Is Savaria (TSE:SIS) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Savaria Corporation (TSE:SIS) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Savaria

What Is Savaria's Net Debt?

As you can see below, Savaria had CA$363.6m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CA$43.9m, its net debt is less, at about CA$319.7m.

How Healthy Is Savaria's Balance Sheet?

According to the last reported balance sheet, Savaria had liabilities of CA$167.5m due within 12 months, and liabilities of CA$482.9m due beyond 12 months. Offsetting this, it had CA$43.9m in cash and CA$106.4m in receivables that were due within 12 months. So its liabilities total CA$500.2m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Savaria is worth CA$875.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Savaria has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 3.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Savaria grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Savaria's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Savaria generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

When it comes to the balance sheet, the standout positive for Savaria was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. Considering this range of data points, we think Savaria is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Savaria (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.